The Unshell Directive – Potential Impact for Financial Services


On 22 December 2021, the European Commission published an anti-tax avoidance directive intended to neutralise the misuse of shell entities for tax purposes. Known as ATAD III or the “Unshell Directive”, the draft Directive is aimed at EU-resident entities, including SMEs, partnerships, trusts and other legal arrangements which claim benefits under double tax treaties and other EU Directives, but which lack a minimum level of economic substance.

Whilst economic substance has been a fairly hot topic in recent years, the ATAD III proposals attempt to introduce a more prescriptive, rule-based approach to assessing an entity’s substance, by setting out a series of Gateway Tests intended to identify high risk or “shell” entities. The tests are intended to establish whether an entity has a genuine economic link with its country of residence, laying out a minimum level of activity to determine if there is a misuse of an entity for tax avoidance purposes.

The Gateway Tests

The proposed Directive sets out three “Gateway Tests” that must be assessed by an entity:

Gateway 1: Where more than 75% of the entity’s revenue for the previous two years is passive income or where 75% of the total book value of the entity’s assets comprise of shares, real estate or other valuable private property.

Gateway 2: Where more than 60% of the book value of the entity’s real estate assets and other valuable private property were located outside the Member State of the affected entity in the last two years or where at least 60% of its relevant income (i.e. passive income) is earned or paid out via cross-border transactions.

Gateway 3: Where the entity has, in the preceding two tax years, outsourced the administration of day-to-day operations and decision making on significant functions.

If an entity meets all three of the above, then it must report specified information in relation to economic substance in its tax return.


The proposed Directive provides for a number of carve-outs or exemptions. Undertakings that meet one of the following carve-outs are out of scope of the Directive and thus are not required to demonstrate minimum substance:

  • Listed on a regulated stock exchange
  • Regulated financial undertakings
  • Holding companies with no / limited cross-border elements (e.g. managing local operational businesses, if beneficial owners are tax resident in the same state; or shareholder/ultimate parent entity is resident in the same state)
  • With at least five full-time employees engaged exclusively in activity generating income.

Reporting Obligations

An entity which meets all of the Gateway Tests, and which does not fall within one of the above listed carve outs, will be required to report information in its annual tax returns that indicate whether it meets the “minimum substance requirements”. These are:

  • The entity has its own office space in the Member State, or exclusive use of an office space;  
  • The entity has at least one active bank account in the EU; and
  • Employees/directors meet one of the following two indicators:
  • One or more directors of the entity:
    • Are resident for tax purposes in the Member State of the entity, or lives close enough to the jurisdiction to properly perform their duties;
    • Are qualified and authorised to take decisions in relation to the entity’s income-generating activities or assets;
    • Actively and independently use that authorisation on a regular basis;
    • Are not employees of an enterprise that is not an associated enterprise and do not perform the function of director or equivalent of other enterprises that are not associated enterprises;
  • The majority of the full-time equivalent employees of the undertaking are resident for tax purposes in the Member State of the entity, or live close enough to the jurisdiction to properly perform their duties, and such employees are qualified to carry out the entity’s income-generating activities.

In addition to reporting on the above substance indicators, entities will also be required to accompany their tax returns with documentary evidence.

Where an entity meets all of the substance indicators listed above, and provides satisfactory supporting documentation, it shall be presumed to have minimum substance for the tax year. However, where it fails to meet at least one of the indicators, it shall be presumed not to have minimum substance.


Entities that are presumed not to have minimum substance are allowed to rebut this presumption by providing additional supporting evidence. Such additional evidence includes details of the commercial rationale behind the entity’s establishment in the Member State, information about the employee profiles, and “concrete evidence” that decision-making concerning the activity generating the relevant income is taking place in the Member State.

Tax Consequences

If the substance test is not met, the undertaking would be presumed to be a “shell” and, in addition to reporting obligations, the following would apply:

  • No certificate of tax residency would be granted by local tax authorities (or it would be granted with a specific warning);
  • The entity would not have access to the EU parent-subsidiary and interest-royalty directives or income tax treaties; and
  • The tax authorities of EU Member States would exchange information on the undertaking.

These conditions could result in the company being subject to local withholding tax in the source country or in the taxation of the undertaking’s income at the EU shareholder level.

January 2023 Developments

Following a review of the Directive, the European Parliament Committee on Economic and Monetary Affairs agreed on a number of changes to the proposed Directive, in particular to the “Gateway Tests”. Importantly, the revised version lowers the thresholds below which an entity is not subject to reporting requirements. The European Parliament adopted the European Commission proposal (with the proposed changes) and calls on the European Council to adopt the proposed amendments by the European Parliament Committee on Economic and Monetary Affairs.

The most significant changes to the proposed Directive made by the European Parliament’s Committee on Economic and Monetary Affairs relate to the Gateway Tests, which have been revised as follows:

  • More than 65% (previously 75%) of the revenue in the preceding two years is “relevant income,” which broadly covers passive income (e.g., dividends, interest, royalties);
  • More than 55% (previously 60%) of the book value of the entity's assets has been located outside the undertaking's Member State for at least two years, or more than 55% (previously 60%) of the entity's relevant income is earned through cross-border transactions; and
  • The entity has outsourced the administration of its day-to-day operations and decision-making to a third party (bold text added).

In addition, the European Parliament also removed the proposed carve-out for entities with at least five full-time employees engaged exclusively in activity generating income, made a number of changes to the wording of the minimum substance indicators, and to the wording of the reporting requirements.


The European Parliament’s proposal will now be considered in detail by the Council of the EU, which is not legally obliged to adopt the European Parliament’s amendments. The Unshell Directive requires unanimity by all EU Member States for its adoption. If adopted, the Unshell Directive would have to be transposed into national laws of the EU member states by 30 June 2023 and would be effective as from 1 January 2024. However, since there is a two-year look-back period in determining whether the economic substance indicators are met, the directive would — in a sense — apply retroactively as from 1 January 2022. In any case, given the ongoing negotiations at the level of the European Council (including the lookback period and implementation), the effective date of the Unshell directive may be postponed.

Potential Impact for Financial Services Industry

As mentioned above, one of the carve-outs is for “regulated financial undertakings”.

Financial undertakings have been excluded from the scope of the Directive on the basis that they are heavily regulated within the EU, and subject to increased transparency requirements and supervision. Thus they are unlikely to present a risk of lacking substance for tax purposes.

For the purposes of the proposed Directive, “regulated financial undertaking” includes:

  • Banks and other credit institutions
  • Investment firms
  • AIFs, UCITS funds, and their managers of AIFs and UCITS
  • Insurance and reinsurance companies
  • Pension funds
  • Central counterparties and central securities depositories
  • Securitisation SPVs
  • Payment institutions
  • Electronic money institutions
  • Crowdfunding service providers
  • Crypto-asset service providers

While this will be a welcome exclusion, it is important to note that the exclusion will not apply to all financial services companies, only to those which are themselves regulated. The Directive would still apply to non-regulated entities within a financial services group. This could include holding companies, finance companies, leasing entities, certain Section 110 companies (that do not fall within the carve-out), and other special purpose vehicles. 

What steps should businesses be taking?

We would strongly recommend that any groups with EU entities that may be at risk consider these rules sooner rather than later.

It will be important for companies to consider whether the gateway exemptions may apply now (give the two-year look-back rule) or if entities within a current group structure will be within scope, and how this could affect the group tax position overall. Where a group has holding companies that are no longer in use, it may be appropriate to remove any which might fall foul of the rules – otherwise, reporting obligations may arise even if there is no tax impact from the loss of access to treaties/directives.

How BDO can help

We can help examine at-risk entities within the group structure and assist in mitigating any adverse tax impact arising under the proposals.

For more information on this topic, please contact Angela Fleming, Head of Financial Services Tax, or your usual BDO tax contact.